Personal Finance

What are Mutual Funds?

To understand “what are mutual funds” and what constitutes a mutual fund unit, let’s start with an example. To grasp the concept of a mutual fund unit, imagine a group of 4 friends wanting to buy a box of 12 chocolates costing ₹40. Each friend has only ₹10, so they pool their money to buy the box. Each friend gets 3 chocolates or 3 units based on their contribution, analogous to mutual fund units. 

The cost per unit is calculated by dividing the total amount by the total number of chocolates, which is 40/12 = 3.33. Thus, each friend is a unit holder in the box of chocolates, making them part-owners of the box.

What is Net Asset Value (NAV)?

Just like an equity share has a traded price, a mutual fund unit has a Net Asset Value (NAV). The NAV is the combined market value of the shares, bonds, and securities held by a fund on any given day, minus permitted expenses and charges. 

NAV=Total Assets−Total Liabilities / Number of Outstanding Shares

Here’s what each part means:

• Total Assets: All the investments the fund owns, like stocks, bonds, and cash.
• Total Liabilities: All the money the fund owes, including fees and expenses.
• Number of Outstanding Shares: The total number of shares held by investors.

Advantages of Investing in Mutual Funds

If you understand what mutual funds are you will know that it is also ideal for those investors who lack large sums for investment or don’t have the time to research the market, but still want to grow their wealth. 

Here are the advantages of investing in mutual funds:

• Diversification: Mutual funds spread your investment across various assets, reducing the risk of any one investment losing value. This is like not putting all your eggs in one basket. If one company you’ve invested in goes bankrupt, you won’t lose all your money.

ALSO READ: WHAT ARE ASSET CLASSES & THEIR TYPES 

• Professional Management: Mutual funds are managed by experienced professionals who research and know all the answers to the question. This saves you time and effort, and you can benefit from their expertise.

• Affordability: Mutual funds allow you to invest in a variety of assets that you might not be able to afford to buy on your own. For example, you can invest a small amount of money in a mutual fund that invests in large, established companies.

• Liquidity: Most mutual funds are open-ended, which means you can buy and sell shares on a daily basis. This gives you access to your money when you need it.

• Convenience: You can invest online, through a robo-advisor, or with a financial advisor. You can also set up automatic investments so you can invest regularly without having to think about it.

• Tax Benefits: Investing in mutual funds provides tax advantages. For example, you can postpone capital gains taxes on mutual funds if you hold them for over a year.

CHECK THIS OUT: MUTUAL FUNDS VS EQUITY – WHICH IS BETTER?

Variety of Mutual Fund Schemes

The Indian mutual fund industry offers a plethora of schemes catering to different investor needs. These schemes help investors achieve various financial goals, such as post-retirement expenses, children’s education or marriage, and house purchases. Mutual funds provide an excellent avenue for retail investors to benefit from market uptrends. However, selecting the right fund requires proper due diligence, considering the risk-return trade-off and investment time horizon, or consulting a professional investment advisor.

Diversification: Key to Maximizing Benefits

To reap the maximum benefit from mutual fund investments, it is important to know-what are mutual funds, what are the different types of funds across different categories such as equity, debt, and gold. While investors can invest in securities markets on their own, mutual funds offer a packaged benefit, making them a better choice.

Types of Mutual Fund Schemes

Mutual fund schemes can be categorized into open-ended and closed-ended schemes and further into actively managed and passively managed funds.

1. Open-Ended Funds: These schemes are available for subscription and redemption throughout the year. They do not have a maturity date and operate similarly to a savings bank account, where one can deposit and withdraw money daily.

2. Closed-Ended Funds: These schemes are open for subscription only during the initial offer period and have a fixed maturity date. Units of closed-ended funds can only be redeemed upon maturity. However, these units are listed on a stock exchange, allowing investors to trade them like other stocks before maturity.
3. Actively Managed Funds: In these schemes, the fund manager actively manages the portfolio, making decisions on which stocks to buy, sell, or hold based on professional judgment and analytical research. The goal is to generate maximum returns and outperform the scheme’s benchmark.
4. Passively Managed Funds: These funds follow a market index, and the fund manager does not use discretion in managing the portfolio. Instead, they replicate or track the scheme’s benchmark index in the same proportion. Examples include Index Funds and Exchange-Traded Funds (ETFs). The aim is to match the returns of the index, not to outperform it.

Risk/Return Trade-Off by Mutual Fund Category

The risk/return trade-off is an important investing concept that shows the relationship between investment risk and expected return. Mutual funds have different levels of risk and return potential. Investors must understand this trade-off to make the right investment choices based on their financial goals, risk tolerance, and investment horizon.

1. Equity Funds

Risk Level: High
Return Potential: High

Equity funds invest primarily in stocks and aim for capital appreciation over the long term. They can offer substantial returns but have higher volatility and risk due to market fluctuations. Within equity funds, there are various subcategories:

• Large-Cap Funds: Invest in large, well-established companies. They offer relatively stable returns with moderate risk.
• Mid-Cap Funds: Focus on medium-sized companies with high growth potential, offering higher returns but also higher risk.
• Small-Cap Funds: Invest in smaller companies, which can provide significant returns but are highly volatile and risky.
• Sector/Thematic Funds: Target specific sectors (e.g., technology, healthcare) or themes. They can yield high returns if the sector performs well but are riskier due to lack of diversification.

2. Debt Funds

Risk Level: Low to Moderate
Return Potential: Low to Moderate

Debt funds invest in fixed-income securities like bonds, government securities, and money market instruments. They are generally less volatile than equity funds and aim to provide steady returns with lower risk. Subcategories include:

• Liquid Funds: Invest in short-term instruments with high liquidity and low risk. Ideal for parking surplus funds for short durations.
• Short-Term and Ultra Short-Term Funds: Invest in debt instruments with short maturities, offering slightly higher returns than liquid funds with moderate risk.
• Income Funds: Invest in a mix of medium to long-term debt instruments, providing regular income with moderate risk.
• Gilt Funds: Invest in government securities with no credit risk but are subject to interest rate risk.

NOW READ: EQUITY VS DEBT MUTUAL FUNDS

3. Hybrid Funds

Risk Level: Moderate
Return Potential: Moderate to High

Hybrid funds, also known as balanced funds, invest in a mix of equities and debt instruments to balance risk and return. They cater to investors seeking a moderate risk-return profile. Key subcategories include:

• Aggressive Hybrid Funds: Allocate a higher proportion to equities (65-80%) and the rest to debt, offering higher returns with moderate risk.
• Conservative Hybrid Funds: Invest more in debt (70-90%) and a smaller portion in equities, providing stable returns with lower risk.
• Balanced Advantage Funds: Dynamically adjust the allocation between equity and debt based on market conditions, aiming to optimize returns while managing risk.

4. Index Funds and ETFs

Risk Level: Varies with the Index
Return Potential: Market-Linked

Index funds and Exchange Traded Funds (ETFs) replicate the performance of a specific market index (e.g., Nifty 50, S&P 500). They offer returns similar to the index they track and come with relatively lower management fees. The risk and return depend on the volatility of the underlying index. These funds are suitable for investors seeking market returns with lower costs.

5. Gold Funds

Risk Level: Moderate
Return Potential: Moderate

Gold funds invest in gold and related instruments, offering a way to invest in the precious metal without holding physical gold. They provide a hedge against inflation and currency fluctuations, making them a valuable part of a diversified portfolio. However, returns depend on gold prices, which can be volatile.

6. International Funds

Risk Level: High
Return Potential: High

International funds invest in stocks and securities of companies outside the investor’s home country. They offer exposure to global markets and diversification benefits but come with higher risks due to currency fluctuations, geopolitical factors, and differing market dynamics.

How to Invest in Mutual Funds

Investing in mutual funds is a straightforward process. 

• First, identify your financial goals and risk tolerance. Decide if you want to invest for short-term gains or long-term growth. Next, research all the details regarding – what mutual funds are and choose a mutual fund that aligns with your goals. You can compare mutual funds based on their past performance, risk level, and the fund manager’s expertise.
• Once you’ve selected a fund, open an account with a mutual fund company or through an online investment platform. You will need to complete a simple application form and submit necessary identification documents. After your account is set up, you can invest a lump sum or start a Systematic Investment Plan (SIP), where you invest a fixed amount regularly.
• Regularly monitor your investment to ensure it aligns with your objectives. If adjustments are necessary, you can modify your investments or seek advice from a SEBI-registered investment advisory

Risks of Investing in Mutual Funds

While mutual funds offer several benefits, they are not free from risks. Market volatility, interest rate changes, and economic factors can impact the performance of mutual funds. It is essential to research all the details regarding – what mutual funds are to navigate mutual funds investment risks and diversify your investments to reduce potential losses.

Conclusion

Mutual funds offer investors a way to pool their resources to gain access to a mix of asset classes. With a variety of schemes available, they cater to different financial goals and risk appetites. By understanding the basics of mutual funds, evaluating your financial objectives, and conducting proper due diligence, you can make informed investment decisions and achieve your financial goals efficiently.

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

FAQ

If you’re new to investing, one of the terms you might bump into daily is NAV. NAV stands for Net Asset Value. Let’s break down what NAV means, and how you can calculate it, one of the most important thing to know before selling mutual funds or buying them.

Net Asset Value (NAV) Meaning

Net Asset Value (NAV) is the value of one share of a mutual fund, exchange-traded fund (ETF), or other investment fund. If a mutual fund is a pizza then NAV is nothing but the price of one slice of that pizza. NAV shows the value of all the fund’s assets minus any debts, divided by the number of shares. In a nutshell, NAV is the price at which you buy or sell a unit of a fund on a given day.

Net Asset Value Formula

Calculating NAV is simple with this formula:

NAV=Total Assets−Total Liabilities / Number of Outstanding Shares

Here’s what each part means:

• Total Assets: All the investments the fund owns, like stocks, bonds, and cash.
• Total Liabilities: All the money the fund owes, including fees and expenses.
• Number of Outstanding Shares: The total number of shares held by investors.

How is the Net Asset Value Calculated?

Daily Net Valuation of Assets

Mutual fund companies use the net asset value method to evaluate the total value of their portfolio every day after the stock market closes at 3:30 p.m. The next day, the market reopens with the closing prices from the previous day. Fund managers then deduct all expenses to arrive at the net asset value for the day using the formula mentioned above.

Know more: Stocks screener

General Calculation of the Net Value of Assets

The general net asset value refers to the price of an equity share, calculated by the cumulative cost of individual shares. This reflects the market value of a particular asset, which can change based on market fluctuations.

Role of NAV in the Performance of a Fund

Many investors mistakenly believe that the net asset value is equivalent to a stock’s price, assuming funds with a lower NAV are cheaper and better investments. However, the NAV doesn’t directly correlate with a fund’s performance, for that matter even for a stock. A lower NAV doesn’t necessarily mean the fund is a better investment.

The NAV indicates how the underlying assets have performed over the years. Investors should not rely solely on NAV when choosing funds. Instead, they should consider the fund’s returns, assets under the fund, and historical performance to make informed decisions.

Why NAV is Important

1. Performance Tracking: NAV helps you track how well your investment is doing over time. By looking at the NAV at different times, you can see if the fund’s value is going up or down.
2. Fair Pricing: For mutual funds, NAV ensures that everyone buys and sells shares at a fair price, preventing anyone from gaining an unfair advantage.
3. Transparency: Regular NAV calculations and updates keep everything clear and open, helping you trust the value of your investment.

Know more about
FINANCIAL CALCULATORS | SIP CALCULATOR | RETIREMENT CALCULATOR | CAGR CALCULATOR | 

Conclusion

Understanding Net Asset Value (NAV) is crucial for anyone investing in mutual funds or ETFs. Knowing the net asset value formula and how to use the net asset value method can help you make better investment decisions. By grasping the net asset value meaning and asking questions like what is net asset value, you can become a more informed and confident investor, and if you find yourself to be an inexperienced investor, you must consider financial advisory services that help you manage your money better, maybe they can also spill the secret sauce why billionaires don’t invest in mutual funds, and after that, your investment can match that of an HNI investment.

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

FAQ

You’re familiar with a regular SIP if you’re a mutual fund investor. You invest a fixed amount each month on a set date, with minimal ongoing management. While this tried-and-true investment strategy guarantees consistency, it may miss out on market opportunities.

Think of a smarter and more complicated version of vanilla SIPs with a dynamic feature that responds to market conditions. That’s what we call Smart SIPs, which adjust investment amounts using a variety of sophisticated algorithms. The goal is to maximize returns by capitalizing on market fluctuations.

Although it may surprise you, it is true.

We’ve created an article about Smart SIPs for smart investors like you. This article explains the fundamental concepts of Smart SIPs, including how they work, how they differ from regular SIPs, and much more. So let’s tune in.

What are SIPs, and how do they work?

A Systematic Investment Plan (SIP) is a method of making a fixed contribution at a pre-determined frequency (monthly/quarterly) in a mutual fund. It’s like creating a financial fitness routine for your money. This is how it works.

Regular Contributions: When you set up a SIP, a fixed amount is deducted from your account each month (or at your preferred frequency). This amount is then invested in a mutual fund of your choosing.

Rupee Cost Averaging: SIPs save you from the stress of timing the market. The mutual fund price will fluctuate from month to month. Your investments accumulate over time, allowing you to benefit from an average cost. This approach is commonly referred to as rupee cost averaging.

What are Smart SIPs, and how do they work?

Smart SIPs are an innovative investing technique in which the SIP amount varies based on market valuations. The guiding principle in Smart SIPs is to Buy Low and Sell High.

Smart SIPs, also known as Flexi SIPs, are automated decisions that use a complex algorithm to calculate the SIP amount by evaluating valuation indicators such as market levels, P/E ratio, P/B ratio, PEG, and other factors.

When you start your Smart amount, you choose the base amount. The base amount (or your SIP amount) is adjusted based on current market sentiments and valuations.

When valuations are low, double the base amount is invested. When the valuations are neutral, the base amount is invested. As valuations rise, the base amount is halved, temporarily invested in liquid funds, or not invested. 

Comparing Smart SIPs and Normal SIPs

Example of Smart SIPs vs Regular SIPs

Let us use an example to illustrate this concept better.

Now, let’s do the check:

Smart SIP led to approximately ₹11,950 higher gains than traditional SIP. However, it is interesting to note that a larger total amount was invested in the case of Smart SIP.

When deciding between these options, consider their risk tolerance and the market outlook.

Benefits of Smart SIPs

Market-Responsive Investing: Smart SIPs adjust equity investments based on market valuations. The equity allocation is done based on two parameters:

1. market trends and sentiments, and

2. technical valuation indicators like the P/E ratio. 

So, to reduce risk during overvalued periods, only a portion of your SIP amount goes into equities or is invested in less volatile vehicles, reducing risk during overvalued periods.

Potential for Better Returns: Smart SIPs aim to optimize returns by capitalizing on market fluctuations. During market downturns, they acquire more assets, potentially boosting overall performance. In addition to rupee-cost averaging, Smart SIPs also do value averaging.

Disciplined Approach: Like traditional SIPs, Smart SIPs encourage regular investing, promote discipline, and harness the power of compounding. They also eliminate emotions from the decision-making process.

Drawbacks of Smart SIPs

• Algorithm Dependency: Smart SIPs rely on algorithms to determine investment amounts. While this can be advantageous, it also means trusting the algorithm’s accuracy.
• Market Timing Risk: If the algorithm misjudges market conditions, you might miss out on potential gains during bullish phases.
• Higher Fees: Some Smart SIPs may charge higher fees due to their dynamic investment approach and frequent reallocations.

Who Should Consider Investing in Smart SIPs?

Smart Systematic Investment Plans (SIPs) are well-suited for you if:

• You are tech-savvy and are comfortable with automated AI-driven investment strategies.

• You are a long-term planner and committed to consistent, disciplined investing.

• You are high-risk tolerant and are willing to navigate market fluctuations.

• You are comfortable investing higher amounts when the market dips, and the variable SIPs don’t spoil your budget.

The Bottom Line 

Smart SIPs could be a useful tool for investors with a long-term outlook and a tolerance for higher risk. With data-driven and automated algorithms to assess whether markets are inflated, flat, or expensive, your SIP amount differs each month. Your equity allocation also changes depending on the market trends.

Traditional SIPs, on the other hand, are still a reliable and tried-and-true strategy for those who prefer a simpler, more hands-off approach. Encourages disciplined investing when you know how much you’re going to invest each month.

If you want to accumulate wealth over time without actively participating in the market, regular SIPs are better suited to your needs.

To be on the safe side, consult with an experienced financial advisor to determine which approach is most fitting for your specific financial goals. 

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

FAQ

Personal loans have become an increasingly popular financial tool in India, catering to a variety of needs, from medical emergencies and weddings to consolidating debt and funding vacations. While personal loans offer significant advantages, they also come with potential drawbacks that can impact an individual’s financial planning. This article explores both sides of the equation, providing a comprehensive overview of how personal loans can affect financial planning in India.

A recent study showed that 53% of Indians took their first personal loan before age 30, and 22% of the personal loan consumers were under age 25. This signifies an upward trend in young people being aware of their finances and making decisions. Let’s understand personal finance first and later on understand the pros and cons. 

What are Personal Loans?

Personal loans in India are popular financial products offered by banks, non-banking financial companies (NBFCs), and digital lending platforms. These loans are unsecured, meaning they do not require collateral. Here are some key aspects of personal loans in India:

• Loan Amount: Ranges typically from ₹10,000 to ₹40 lakhs, depending on the lender and the borrower’s eligibility.
• Tenure: Usually ranges from 1 to 5 years, though some lenders may offer up to 7 years.
• Interest Rates: Vary widely based on the lender, the borrower’s credit profile, income, and other factors. Rates generally range from 10% to 24% per annum (are subject to change).
• Processing Time: This can be as quick as a few hours to a few days, depending on the lender and the completeness of documentation.
• Documentation: Generally includes proof of identity, address, income, and employment.

Understanding Personal Loans in India

1. Features and Benefits of Personal Loans

• Unsecured Loan: Unlike home or car loans, personal loans do not require collateral, making them more accessible.
• Flexible Loan Amount: Depending on eligibility, loan amounts range from ₹10,000 to ₹40 lakh.
• Fixed Interest Rates: Personal loans generally have fixed interest rates ranging from 10% to 24%.
• Varied Tenure: Repayment periods typically range from 1 to 5 years, with some lenders offering up to 7 years.
• Quick Processing: Many banks and NBFCs approve personal loans within 24-48 hours.

2. Key Reasons for Taking a Personal Loan

• Medical Emergencies: Quick access to funds for unexpected medical expenses.
• Higher Education: Financing for tuition, books, or study-abroad programs.
• Debt Consolidation: Paying off multiple high-interest debts with a single lower-interest personal loan.
• Home Renovation: Improving home infrastructure without depleting savings.
• Wedding Expenses: Managing big-ticket expenses associated with Indian weddings.

3. Current Trends in Personal Loan Interest Rates in India

The interest rates on personal loans in India depend on factors such as credit score, income, employment stability, and the lender’s policies. Here’s an overview of the current trends:

Advantages of Personal Loans for Financial Planning

1. Quick Access to Funds Without Collateral

Personal loans provide immediate liquidity without requiring assets as security. This is beneficial for those who do not have property or gold to pledge.

2. Flexible Usage for Short-Term Financial Needs

Unlike home or auto loans, which are meant for specific purposes, personal loans can be used for various financial requirements, from medical expenses to travel and education.

3. Consolidating High-Interest Debts to Save Money

Many individuals take personal loans to consolidate credit card debt or high-interest loans into one structured repayment plan, often at a lower interest rate.

Challenges of Using Personal Loans in Financial Planning

1. High Interest Rates Compared to Secured Loans

Since personal loans are unsecured, lenders charge higher interest rates than secured loans (like home or car loans), increasing the cost of borrowing.

2. Risk of Overborrowing and Debt Traps

Easy availability can lead individuals to overborrow, increasing financial stress and leading to a cycle of debt.

3. Impact of Missed Payments on Credit Score

Late or missed payments can significantly impact the borrower’s creditworthiness, making it harder to secure loans in the future.

Personal Loan Impact on Credit Score

1. How Timely Repayments Improve Credit Ratings

Regular EMI payments demonstrate creditworthiness, improving the borrower’s CIBIL score.

2. Negative Consequences of Defaults on Credit History

Non-repayment leads to credit score deterioration, impacting future borrowing capabilities.

3. Tips to Maintain a Healthy Credit Score While Using Loans

• Make Timely Payments: Avoid late penalties.
• Limit Borrowing: Take loans only when necessary.
• Monitor Credit Report: Check for errors and discrepancies.

Best Practices for Financial Planning With Personal Loans

1. Evaluating Loan Needs Based on Financial Goals

Before applying for a personal loan, assess whether the loan aligns with long-term financial objectives.

2. Comparing Personal Loan Interest Rates Across Lenders

Compare offers from multiple banks and NBFCs to get the best rate.

3. Using EMI Calculators for Better Budgeting

Utilize online EMI calculators to determine affordability and repayment feasibility.

How Personal Loans Can Fit Into Long-Term Financial Goals

1. Planning for Emergencies Without Disrupting Investments

A personal loan can help manage unforeseen expenses without liquidating long-term assets like fixed deposits or mutual funds.

2. Using Loans Strategically for Wealth Creation

Borrowing for education or skill enhancement can lead to higher future earnings.

3. Avoiding Overdependence on Loans for Lifestyle Needs

Using loans for luxury purchases or discretionary expenses can lead to financial strain.

Conclusion:

Understanding the impact of personal loans on financial planning in India is crucial for making informed financial decisions. While personal loans offer flexibility and quick access to funds, they come with higher interest rates and can impact your monthly budget. Evaluating the pros and cons can help you decide whether a personal loan is the right choice for your financial needs.

Also Read:

• Financial Calculators
• CAGR Calculator
• Retirement Planning Calculator
• SIP Calculator

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